As peso continues to strengthen against dollar BSP vows to maintain market-determined exchange rate

MANILA, Philippines - The peso has been all over the headlines lately as it continues to gain  strength against the dollar, notching one record high after another enough for it to be pronounced as the second best performing currency in the region, next only to Singapore dollar.

While most of the time it tracks highs achieved by the local bourse, the peso’s remarkable performance could have been expected to be treated as good news, maybe warranting a mention on the President’s next State of the Nation Address. Too bad, however, few people are happy our currency is being noticed.

Monetary authorities have been called for more action against the peso, if only to bring it back to levels some sectors considered are enough to keep them on business or at the most for others, keep the economy safe and on track to prosperity.

The first to complain were the exporters. Philippine Exporters Confederation president Sergio Ortiz-Luis could only helplessly reiterate how he wanted the peso to go back to the 42-level, the same level it was at about three months ago. Now, the peso has been traversing the 41-range to a dollar and almost every day, even recording a new 56-month high of 41.05 last Nov. 8.

 “Small and medium indigenous exporters are comfortable with a 42.50 exchange rate. Stronger than that, some of them are already not accepting orders or closing down,” Ortiz-Luis said in a phone interview.

Filipinos abroad and their families here are also feeling the pinch as the money they sent here, at one point convertible to as much as 56 to a dollar, is now getting less value.

The latest to join the clamor were economists who did not only disliked an appreciating peso but have also urged the Bangko Sentral ng Pilipinas (BSP) to act more aggressively to tame it. National scientist Raul Fabella, in a position paper, even characterized the peso’s strength as a “sledgehammer” that killed the growth momentum during the Ramos administration.

But the BSP, despite all the calls, has stood pat on keeping the peso generally market-determined. It has kept its position of only intervening in the peso should there be enough evidence of speculation and if sharp swings have proven to be detrimental to business activities.

Three reasons were provided by BSP Governor Amando Tetangco Jr. for such position: first, the exchange rate affects a wide range of sectors and not only exporters; second, export competitiveness is more than the exchange rate; and finally, an aggressive intervention in the market may result into dire consequences.

The first two had already been answered in previous reports. For the third, let us take a dive in history and also take note of what is happening now and what should be done in the future.

The past: 1940s

Few people know that back in the 1940s, the peso was pegged against the dollar at the exchange rate of  P2 to a dollar. The peg, instituted by a treaty, had been effective for more than two decades and was made, as officials want to put it, because of necessity.

 “We had no choice. We needed the money,” said Jade Eric Redoblado, one of the authors of the article “Economic Crises in the Philippines: 1950s-1970s” published on Tetangco’s book Central Banking in Challenging Times: The Philippine Experience.

He was pertaining to the $800-million in war rehabilitation fund the US was willing to give us then under the Belle Trade Act of 1946 passed by the US Congress. The Philippines, which had only emerged from being a US colony, needed the money for reconstruction after the World War II.

According to the article, the “controversial” law was passed side by side with the Philippine Independence Act which, by the words themselves, freed the country from US colonization. The result was a mixed bag: The Philippines is technically independent, but parts of our sovereignty were still held by the US because of the Belle Trade law. And one of those was the foreign exchange rate.

Francisco Dakila Jr., another author who now works as the director of BSP’s Center for Monetary and Financial Policy (CMFP), said the provision was meant to protect US investments in the country.

 “The law also stated that US citizens will have equal rights over our natural resources and to operate public utilities here. So the issue was, if for example an American has business here and the peso suddenly weakened, profits he is earning may get trimmed. That is why they inserted that provision,” Dakila told The STAR.

 “The P2:$1  rate was not in the law, what was in the law was the exchange rate should be pegged. I think they decided to use the pre-war exchange rate to ensure confidence,” he added.

At the same time however, the Philippines was also granted some incentives under the Belle Trade Act. Dakila said Filipinos could also “technically” invest in the US and make it a “sure market” for exports. “Unfortunately, this was not fully exploited by the Philippines as policies turned inward-looking,” the article said.

The result was devastating: the country operated for years with balance of payments (BOP) deficits, an indication that it had no enough supply of dollars to service its imports such as food and raw materials needed for reconstruction, and pay foreign debts.

 “The solution was a system of control. Since it had limited dollars, what the government did was to allocate its dollars to those considered as essentials, leaving others behind,” Dakila pointed out.

This put a dent on economic growth as local companies remained weak after the war, while foreign investors were shunned away by the Philippines’ failing macroeconomy. Technically speaking, slowing growth does not create enough jobs for a growing population, resulting into poverty.

 “It was a missed opportunity. If only we were more outward looking, we could have taken advantage of the US as an export market. But since we were more concerned on meeting our needs here and since we are in BOP deficit, we were not able to do it,” Dakila explained.

For Redoblado, the country missed “a big opportunity to accelerate industrialization.”

 “That time, the (major) electric industry in Asia was planning to transfer to the Philippines (from Shanghai) but we let go of that opportunity,” he said.

Dakila said: “This showed that records from our own history depict that a pegged peso is not feasible.”

The present: 2012

While the Philippines — with contained deficit, BOP surplus and high reserves — is in a far better position now than in the 1950’s, Dakila said it would be a “step backwards” to peg the peso even on a particular trading band just like what China is doing with the yuan.

He said even prescribing a minimum point for the peso would be detrimental to the economy, especially now when emerging countries, such as the Philippines, are boosting their buffers and space for maneuver at this time when developed nations, particularly Europe, are in crisis.

There could be “some sectors” such as the export industry could benefit from such move, he claimed, but a “bigger loss” would have to be dealt with by the BSP, the one that assures price stability in the economy. As such, the whole country could suffer.

““The question here is how you will be able to support that. China is able to do it because it is still relatively a closed economy. When you do that here, you will need to go back to the foreign exchange controls we had in the 1950s,” Dakila said.

That means, Redoblado said, that the BSP will have to support the peg by buying the dollars that will enter the country. As a result, the market will be flooded with pesos which could stoke inflation and derail growth.

 “That would also be illegal because under our Charter, our primary mandate really is price stability,” he said.

Should, for example, BSP decided to cap the peso at 42.50 for exporters, Emilio Neri, economist at the Bank of the Philippine Islands (BPI), said the central bank would “have to buy dollars more aggressively,” releasing more pesos into the system.

Dakila said the Philippines, an open economy, could not take the China’s position in yuan, which has been under control for decades. Chinese monetary authorities only allow their currency to trade one percent stronger or weaker against the dollar from a prescribed midpoint.

 “China is still a command economy. It is still generally close and you cannot invest freely in China. There are still so many controls,” he explained.

The worst case scenario would be if once the peso is pegged, new crises like that which happened in 1997 and that which is happening now in Europe emerge. In fact, Dakila said the euro zone nations — the 17 countries sharing one currency under crisis — are now feeling the bite of having what he calls a “permanent peg.”

Redoblado, who also works at the CMFP, said the euro has made it harder for countries such as Greece to recover from almost five years of recession.

 “It was a fiscal problem at the start, but they could have done better just like some Asian countries during the financial crisis which exported their way out. Greece could not do that because it has the same currency with its trading partners,” he explained.

In 1997, a financial crisis hit Asia and some countries, such as Singapore, survived it by boosting their export industry with the help of devalued currencies. A weak currency generally makes export products cheaper abroad, making them more competitive.

 “If Greece had a different currency, it will be devalued because its economy is in disarray. That could make its exports more competitive since they are cheaper abroad,” Redoblado said.

The future: The ‘long term’ solution

Officials and analysts are one in pointing to a “long term” solution to the peso’s appreciation.

 “We should have more imports,” Finance Undersecretary Gil Beltran said. Having more imports, he said, would “balance” inflows and outflows and thus help tame the peso’s appreciation.

To be able to do this, Dakila said local companies should be allowed to do business more. Redoblado said “when you invest, part of your investments has an imported component.” That, in effect, will result into more outflows and prompt demand for dollars.

Data from the National Statistics Office showed the Philippines had a trade deficit worth $1.259 billion in August. This meant the country imported more resources than exported. However, while exports have been growing at 5.4 percent for the first eight months, imports have slowed down to just 0.1 percent.

The good news is, the Philippines has the “potential” to do that, Dakila said, if only the government would be able to reduce hindrances such as “red tape” for businesses to prosper.

 “Best of all solutions will be to encourage the private sector to invest and actually if you look at the economy, there is the potential. All the potentials are there and the potentials are not that dependent on foreign investments. We have the domestic resources,” he explained.

BPI’s Neri agreed and even pointed to the nearest possible solution: the government’s public-private partnership (PPP) initiative which aimed to tap private sector capital to build public infrastructure. So far however, out of the eight projects promised to be rolled out this year, only three have come to fruition.

 “There is much anticipation that the infrastructure spending will pick up together with the private sector. That could help improve the exchange rate,” he said.

Beltran said PPP could also promote “non-inflationary” growth. “Your imports will rise because you are importing capital. Since this capital will be used for production, you are promoting growth and inflation can also be avoided.”

For now however, Neri said the exchange rate will have to be dealt with in the hopes the appreciation will only be “temporary.” Besides, he said, BSP will always be ready to intervene in case sharp swings happen.

BSP Deputy Governor Diwa Guinigundo agreed: “Our stand is to have a market-determined exchange rate with scope to intervene to smoothen volatility and avoid sharp swings.”